Law Commons^™

The Economic (In) Significance Of Executive Pay Esg Incentives, David I. Walker

Faculty Scholarship

The hottest topic in corporate governance circles today involves company commitments to and pursuit of ESG (environmental, social, and governance) initiatives in addition to the traditional pursuit of profits. One facet of this debate has to do with how to motivate executives to pursue ESG goals. Increasingly, companies tie executive pay to ESG performance, although even strong ESG advocates debate the advisability of doing so. This Article joins the fray by closely examining ESG-based CEO pay arrangements at a subset of companies with leadership positions on the Business Roundtable, an industry trade group that embraced ESG in a 2019 statement …

Corporate Finance For Social Good, Dorothy S. Lund

Faculty Scholarship

Corporations are under pressure to use their outsized power to benefit society, but this advocacy is unlikely to result in meaningful change because corporate law’s incentive structure rewards fiduciaries who maximize shareholder wealth. Therefore, this Essay proposes a way forward that works within the wealth-maximization framework and yet could result in dramatic social change. The idea is simple: Use private debt markets to provide incentives for public-interested corporate action. Specifically, individuals who value prosocial corporate decisions could finance them by contributing to corporate social responsibility (CSR) bonds that would offset the corporation’s implementation costs. To provide an incentive to depart …

Does Tax Matter? Evidence On Executive Compensation After 162(M)'S Repeal, Gregg Polsky, Brian Galle, Andrew Lund

Scholarly Works

As part of the most sweeping federal tax reform in a generation, the Tax Cuts and Jobs Act (“TCJA”) radically altered the tax treatment of compensation paid to senior executives of public companies. Prior to the TCJA, payment of such compensation in excess of one million dollars was non-deductible except to the extent the compensation was performance-based. The TCJA eliminated the exception so that all senior executive compensation above one million dollars is now non-deductible regardless of whether it is performance-based or not.

This reform provides a natural experiment to study the role of tax law in influencing managerial pay …

Executive Pay Clawbacks And Their Taxation, David I. Walker

Faculty Scholarship

Executive pay clawback provisions require executives to repay previously received compensation under certain circumstances, such as a downward adjustment to the financial results upon which their incentive pay was predicated. The use of these provisions is on the rise, and the SEC is expected to soon finalize rules implementing a mandatory, no-fault clawback requirement enacted as part of the Dodd-Frank legislation. The tax issue raised by clawbacks is this: should executives be allowed to recover taxes previously paid on compensation that is returned to the company as a result of a clawback provision? This Article argues that a full tax …

Common Ownership And Executive Incentives: The Implausibility Of Compensation As An Anticompetitive Mechanism, David I. Walker

Faculty Scholarship

Mutual funds, pension funds and other institutional investors are a growing presence in U.S. equity markets, and these investors frequently hold large stakes in shares of competing companies. Because these common owners might prefer to maximize the values of their portfolios of companies, rather than the value of individual companies in isolation, this new reality has lead to a concern that companies in concentrated industries with high degrees of common ownership might compete less vigorously with each other than they otherwise would. But what mechanism would link common ownership with reduced competition? Some commentators argue that one of the most …

Employer Losses And Deferred Compensation, David I. Walker

Faculty Scholarship

Most large public companies offer their executives the opportunity to defer the receipt and taxation of their salary or other current compensation until retirement or some other future date, and equity compensation, which also entails deferral of pay and taxation, constitutes a large fraction of the typical executive pay package. Conventional wisdom holds that employer net operating losses (NOLs) improve the joint economics of deferred and equity compensation (henceforth together "deferred compensation") for the parties. However, empirical studies provide little evidence of an association between employer NOLs and deferred compensation use. This paper focuses on two potential explanations for this …

Securities Disclosure As Soundbite: The Case Of Ceo Pay Ratios, Steven A. Bank, George S. Georgiev

Faculty Articles

This Article analyzes the history, design, and effectiveness of the highly controversial CEO pay ratio disclosure rule, which went into effect in 2018. Based on a regulatory mandate contained in the Dodd-Frank Act of 2010, the rule requires public companies to disclose the ratio between CEO pay and median worker pay as part of their annual filings with the Securities and Exchange Commission (SEC). The seven-year rulemaking process was politically contentious and generated a level of public engagement that was virtually unprecedented in the long history of the SEC disclosure regime. The SEC sought to minimize compliance costs by providing …

Executive Compensation In The Charitable Sector: Beyond The Tax Cuts And Jobs Act, Lauren Rogal

Vanderbilt Law School Faculty Publications

The Tax Cuts and Jobs Act of 2017 (“TCJA”) reformed charity executive compensation for the first time in decades, introducing an across-the-board excise tax on compensation over $1 million.1 Its enactment represents a significant step toward securing accountability for the use of the charitable tax exemption under Section 501(c)(3) of the Internal Revenue Code. These organizations receive preferential tax treatment to subsidize their provision of socially beneficial outputs that would otherwise be undersupplied. Overcompensation of charity executives subverts this purpose by diverting those subsidies for private gain and undermining public confidence in the charitable sector.

With the enactment of the …

Greater Expectations: Strategies For Effective Board Meeting Preparation, Jonathan Kim, Marcel Bucsescu

Ira M. Millstein Center for Global Markets and Corporate Ownership

Directors face an increasingly complex environment in which their businesses operate. That complexity can present opportunities for corporations that adapt, and also places new pressures on boards to respond effectively. One strategy for directors to consider is to adapt their approaches to preparing for board meetings by focusing not just on company specific reporting and decisions, but also by acting as the “eyes and ears” for management on key issues for the company. This article makes practical suggestions for directors to consider as they approach their board meeting preparation with this broader view in mind.

Tournament Of Managers: Lessons From The Academic Leadership Market, Usha Rodrigues

Scholarly Works

Why do firms usually make, not buy, their chief executive officers (CEOs)? Public corporations hire their CEOs from within the firm 78% of the time. They do so although earlier studies have found no clear evidence that internal hires perform better than external ones. So why do firms prefer them? Few scholars have focused on this simple question.

The reason why firms favor internal candidates matters not only in its own right, but also for an overlooked reason: it informs the controversial question of executive compensation. Currently board-compensation committees look to peer benchmarks to set executive pay. But, taking cues …

The Way We Pay Now: Understanding And Evaluating Performance-Based Executive Pay, David I. Walker

Faculty Scholarship

Over the last ten years, performance-based equity pay, and particularly performance shares, have displaced stock options as the primary instrument for compensating executives of large, public companies in the U.S. This article examines that transformation, analyzing the structure and incentive properties of these newly important instruments and evaluating the benefits and risks from an investor’s perspective. Notable observations include the following: Although technically “stock” instruments, performance shares mimic the incentive characteristics of options. But performance shares avoid the tax, accounting, and other constraints that have led to uniform grants of non-indexed, at the money options. Performance share plans can be …

The Mess At Morgan: Risk, Incentives And Shareholder Empowerment, Jill E. Fisch

All Faculty Scholarship

The financial crisis of 2008 focused increasing attention on corporate America and, in particular, the risk-taking behavior of large financial institutions. A growing appreciation of the “public” nature of the corporation resulted in a substantial number of high profile enforcement actions. In addition, demands for greater accountability led policymakers to attempt to harness the corporation’s internal decision-making structure, in the name of improved corporate governance, to further the interest of non-shareholder stakeholders. Dodd-Frank’s advisory vote on executive compensation is an example.

This essay argues that the effort to employ shareholders as agents of public values and, thereby, to inculcate corporate …

Nonprofit Executive Pay As An Agency Problem: Evidence From U.S. Colleges And Universities, David I. Walker, Brian D. Galle

Faculty Scholarship

We analyze the determinants of the compensation of private college and university presidents from 1999 through 2007. We find that the fraction of institutional revenue derived from current donations is negatively associated with compensation and that presidents of religiously-affiliated institutions receive lower levels of compensation. Looking at the determinants of contributions, we find a negative association between presidential pay and subsequent donations. We interpret these results as consistent with the hypotheses that donors to nonprofits are sensitive to executive pay and that stakeholder outrage plays a role in constraining that pay. We discuss the implications of these findings for the …

Killing Conscience: The Unintended Behavioral Consequences Of "Pay For Performance", Lynn A. Stout

Cornell Law Faculty Publications

Contemporary lawmakers and reformers often argue that ex ante incentive contracts providing for large material rewards are the best and possibly only way to motivate corporate executives and other employees to serve their firms' interests. This Article offers a critique of the "pay for performance" approach. In particular, it explores why, for a variety of mutually reinforcing reasons, workplaces that rely on ex ante incentive contracts suppress unselfish prosocial behavior (conscience) and promote selfishness and opportunism. The end result may not be more efficient, but more uncooperative, unethical, and illegal employee behavior.

Employee Say-On-Pay: Monitoring And Legitimizing Executive Compensation, Robert J. Rhee

Working Papers

This Article proposes the adoption of employee say-on-pay in corporate governance. The board would benefit from an advisory vote of employees on executive compensation. This proposal is based on two considerations: firstly, the benefits of better monitoring and reduced agency cost in corporate governance; secondly, the link between executive compensation and income inequity and wealth disparity in the broader economy.

If adopted, shareholders and employees would monitor executive performance and pay at different levels. Shareholders through the market mechanism can only monitor at the level of public disclosures and share price. Employees can leverage private information. Non-executive managers in particular …

Sunshine, Stakeholders, And Executive Pay: A Regression-Discontinuity Approach, Brian D. Galle, David I. Walker

Faculty Scholarship

We evaluate the effect of highly salient disclosure of private college and university president compensation on subsequent donations using a quasi-experimental research design. Using a differences-in-discontinuities approach to compare institutions that are highlighted in the Chronicle of Higher Education’s annual "top 10" list of most highly-compensated presidents against similar others, we find that appearing on a top 10 list is associated with reduced average donations of approximately 4.5 million dollars in the first full fiscal year following disclosure, despite greater fundraising efforts at "top 10" schools. We also find some evidence that top 10 appearances slow the growth of compensation, …

Insider Trading Restrictions And Top Executive Compensation, David J. Denis, Jin Xu

Purdue CIBER Working Papers

The use of equity incentives is significantly greater in countries with stronger insider trading restrictions, and these higher incentives are associated with higher total pay. These findings are robust to alternative definitions of insider trading restrictions and enforcement, and to panel regressions with country fixed effects. We also find significant increases in top executive pay and the use of equity-based incentives in the period immediately following the initial enforcement of insider trading laws. We conclude that insider trading laws are one channel through which cross-country differences in pay practices can be explained.

Can Executive Compensation Reform Cure Short-Termism?, Gregg Polsky, Andrew C. Lund

Scholarly Works

There is an increasingly pervasive view among corporate governance observers that senior managers are too focused on short-term results at the expense of long-term interests. Concerns about “short-termism” have been expressed within the financial industry context and outside of it, but because of the recent financial crisis, much of the discussion has been directed at financial institutions. To combat short-termism, several commentators have advocated executive compensation reform to encourage senior managers to adopt a longer-term perspective. Yet these reforms will likely prove ineffective because of other significant pressures on managers to maintain current stock prices.

Should New Zealand Adopt Say On Pay?, Randall Thomas, Susan Watson

Vanderbilt Law School Faculty Publications

No abstract provided.

Sue On Pay: Say On Pay’S Impact On Directors’ Fiduciary Duties, Lisa Fairfax

All Faculty Scholarship

This Article advances a normative case for using say on pay litigation to enhance the state courts’ role in policing directors’ compensation decisions. Outrage over what many perceive to be excessive executive compensation has escalated dramatically in recent years. In 2010, such outrage prompted Congress to mandate say on pay—a nonbinding shareholder vote on executive compensation. In the wake of say on pay votes, some shareholders have brought suit against directors alleging that a negative vote indicates a breach of directors’ fiduciary duties. To date, the vast majority of courts have rejected these suits. This Article insists that such rejection …

Beyond Economics In Pay For Performance, Tamara C. Belinfanti

Articles & Chapters

This article argues that while much of the intellectual energy has focused on the economics of executive pay, the challenge of executive compensation is as much a challenge of human behavior as it is one of economics. The raison d’etre of pay for performance (PFP) is to motivate executives to make decisions that are in the best interest of their firm and its shareholders. Attention to the relevant individual, situational, cultural, and institutional dynamics (what I term “behavioral dynamics”) that affect how executives are motivated and how they value future rewards is critical for the sustainability of PFP as a …

Recoupment Under Dodd-Frank: Punishing Financial Executives And Perpetuating "Too Big To Fail", Joshua Mitts

Faculty Scholarship

In July 2011, the Federal Deposit Insurance Corporation (FDIC) promulgated new rules implementing Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules define a cause of action to recoup compensation paid to senior executives and directors of failed nonbank financial institutions placed into the FDIC's "orderly liquidation authority" receivership. An action for recoupment is based on a negligence theory of liability, but it does not require establishing that an executive's conduct caused the financial institution any harm. The rules presume liability merely for having held executive responsibility prior to the firm entering receivership. The executive …

The Diminishing Returns Of Incentive Pay In Executive Compensation Contracts, Gregg D. Polsky, Andrew Lund

Scholarly Works

For the past 30 years, the conventional wisdom has been that executive compensation packages should include very large proportions of incentive pay. This incentive pay orthodoxy has become so firmly entrenched that the current debates about executive compensation simply take it as a given. We argue, however, that in light of evolving corporate governance mechanisms, the marginal net benefit of incentive-laden pay packages is both smaller than appreciated and getting smaller over time. As a result, the assumption that higher proportions of incentive pay are beneficial is no longer warranted.

A number of corporate governance mechanisms have evolved to duplicate …

A Tax Response To The Executive Pay Problem, David I. Walker

Faculty Scholarship

Many observers believe that that the public company executive labor market is deficient and results in systematically excessive compensation. This Article accepts that premise and considers potential regulatory responses. Specifically, this Article proposes and analyzes a two-pronged tax response to the problem of excessive executive pay – the imposition of a surtax on executive pay in excess of a threshold combined with investor tax relief. These two prongs respond to the chief concerns raised by excessive executive pay. The imposition of a surtax would reduce the after-tax income of executives, which would directly address the unfairness of excessive pay and …

The Unreasonable Case For A Reasonable Compensation Standard In The Public Company Context: Why It Is Unreasonable To Insist On Reasonableness, Stuart G. Lazar

Journal Articles

There is no question that corporate executives are well paid. But does high executive compensation mean excessive or unreasonable compensation? And if so, what is the solution to curbing the problem of excessive executive pay? More specifically, should the Internal Revenue Code be used as a means for regulating the actions of public companies?

This Article briefly explores these issues. In Part I, this Article provides a narrative of the excessive compensation debate. Without drawing a conclusion as to whether executive compensation is reasonably set or excessive in nature, Part I summarizes the history of public outrage surrounding executive pay. …

Making Sense Of The New Financial Deal, David A. Skeel Jr.

All Faculty Scholarship

In this Essay, I assess the enactment and implications of the Dodd-Frank Act, Congress’s response to the 2008 financial crisis. To set the stage, I begin by very briefly reviewing the causes of the crisis. I then argue that the legislation has two very clear objectives. The first is to limit the risk of the shadow banking system by more carefully regulating the key instruments and institutions of contemporary finance. The second objective is to limit the damage in the event one of these giant institutions fails. While the new regulation of the instruments of contemporary finance—including clearing and exchange …

Comparing Ceo Employment Contract Provisions: Differences Between Australia And The United States, Randall Thomas, Jennifer G. Hill, Ronald W. Masulis

Vanderbilt Law School Faculty Publications

The results of our comparison of U.S. and Australian contracts offer some interesting contrasts with several earlier studies that compare U.S. and U.K. CEO compensation. In those prior studies, the authors conclude that U.S. CEOs' compensation is significantly higher than U.K. CEOs' compensation. What is interesting about our initial results is that U.S. CEOs clearly do not have higher base salaries in comparison to Australia. On the other hand, U.S. contracts are much more likely to include restricted stock and stock option features, which generally require payment after a CEO remains at the firm a fixed number of years, typically …

Pay For Banker Performance: Structuring Executive Compensation For Risk Regulation, Frederick Tung

Faculty Scholarship

Excessive risk taking by firm managers did not originate with the Financial Crisis of 2007-08. Though bankers had special incentives to take big risks in the period before the Crisis, the incentive effects of equity-based compensation have been understood for some time. Among other things, equity compensation tends to induce greater risk taking by aligning managers’ risk preferences with those of equity holders. Longstanding government guaranties of bank liabilities additionally served to intensify bankers’ risk taking incentives.

I propose to ameliorate this gambler’s incentive with a new approach to compensation at the largest banks, one that explicitly accounts for the …

Executive Compensation In The Courts: Board Capture, Optimal Contracting, And Officers' Fiduciary Duties, Randall Thomas, Harwell Wells

Vanderbilt Law School Faculty Publications

This Article proposes a new approach to monitoring executive compensation. While the public seems convinced that executives at public corporations are paid too much, so far attempts to rein in executive compensation have met with little success. Several approaches have been tried - requiring large pay packages to consist predominantly of incentive pay, new procedures for approving pay, mobilization of public outrage at giant compensation packages. None, however, has stemmed the growth of executive compensation, or convinced opponents of large pay packages that such pay is either fair or deserved. Here we suggest a new approach, one that turns to …

Evolving Executive Equity Compensation And The Limits Of Optimal Contracting, David I. Walker

Faculty Scholarship

Executive equity compensation in the U.S. is evolving. At the turn of the millennium, stock options dominated the equity pay landscape, accounting for over half of the aggregate ex ante value of senior executive pay at large public companies, while restricted stock and similar compensation accounted for only about ten percent. Beginning in 2006, stock grants have displaced options as the single largest component of senior executive compensation at these firms. Accompanying this shift has been increased variation among companies in their relative emphasis on stock and options in equity pay packages. Both phenomena provide an opportunity for a rich …